Monday, September 16, 2013

Demand for safe assets beginning to decline

I first introduced this chart a few months ago. I think it's a good way to track the world's demand for safe assets. Gold is the classic "safe asset," being both durable and traditionally a refuge from monetary and political risk. 5-yr TIPS are also a "safe asset" since they are default-free, their price is relatively stable, and they offer protection from inflation. As the chart shows, the real yield on TIPS has correlated inversely with the price of gold for most of the past six years. (Another way to say this is that the price of TIPS, which moves inversely to their real yield, has correlated positively with the price of gold.) Both prices have been moving down of late, which I think tells us that the world's demand for safe assets is beginning to decline, after having risen substantially for more than 5 years.

If gold and TIPS are at the cutting edge of the demand for safe assets, then they could be leading indicators of the demand for other safe assets, such as cash, currency, bank savings accounts, and short-term bonds. So far, there is little, if any, evidence that demand for these other safe assets is declining.

U.S. currency in circulation is growing at about a 7% annual rate, or about the same pace it's averaged for the past 4-5 years. There's no sign of any slowdown in the growth rate of currency, and I note that the world's demand for dollars has been relatively stable over this same period.

Similarly, there is no sign of any slowdown in the growth of M2, arguably the best measure of "money." For the past two years, M2 has grown at a 6.5-7% pace, which is only slightly above its long-term average.

Bank savings deposits have been growing at an 11-12% annual pace since the Lehman crisis in Q3//08. The pace of growth has slowed a bit in recent months, but is still relatively strong at 9-10%. Demand for the safety of bank savings deposits is still strong.

After four years of strong and virtually uninterrupted gains, taxable bond funds have experienced significant outflows in the past several months. This is a sign that the world is less anxious for the relative safety of bonds, and this reinforces the message of TIPS and gold.

To judge from this collection of charts, any decline in the world's demand for safe assets is still in its early stages.


Marc Semaan said...

I agree with your point of view that the world's economy is getting better which is reflected by higher interest rates and of course positive real yield. My question is : How do you explain the fact that all these outflows coming from bonds and EM recently went and are still being allocated to deposits and cash (which are even more safe than gold and TIPS) instead of equities ?

Scott Grannis said...

Marc: it's always tricky using cash flows to advance an argument. But two things stand out that I think are worth noting: in the past several months bond funds have suffered outflows for the first time in 4-5 years, and equity funds have not suffered outflows. Equity funds have been chronic losers, and bond funds chronic winners. We are now seeing the first tentative evidence of a shift in favor of equities.

Ed Yardeni has more on this subject here:

Illuninati said...

Mr. Grannis, do you think bond yields world wide are headed up? In Europe they are recovering from the debt crisis, so I assume the recovery will drive down their interest rates. What do you think about other places like Asia?

Benjamin said...

Interesting blogging, but...

Is gold the "ultimate safe asset" or the "dunce-cap's unsafe asset"?

What is the value of gold?

What the next guy will pay...who, btw, is now usually Chinese and Indian. About 60 percent of gold demand is from just those two countries.

If that is a "safe asset" don't show me risky...what if China melts down? And India looking very stodgy right now....

There are no yields or rental income on gold, and usually some storage fees. In contrast, on property there are handsome tax considerations (USA), but none on gold.

As Scott Grannis knows, gold has been a terrible "investment" for long stretches, usually after any gold bull market. Like now.

Why Indians and Chinese have been buying gold is a good question, and may relate to cultural and traditional gift-giving, their rising middle-classes, and tax avoidance (in the case of India). Actually, those trends are long-term bullish on gold. There are a heck of a lot of Indians and Chinese getting richer.

What is clear, is that Gold prices have nothing to do with US monetary policy. The Fed has been doing QE, and gold has been falling. Expanding the money supply is driving the price of gold...down.

Print more money and drive gold prices down. Well, that is what happened in real life. In theory it never happened.

But maybe even in those relatively backward nations of India and China, the demand for gold is waning, as people realize that it has atavistic appeal, but little else. Pretty to look at, but is also nonworking capital you have buried in your own portfolio.

Adjusted for inflation, gold has never recaptured highs of the late 1980s.

From 1982 to 2003, gold hardly budged from around $400 an ounce. That 21 years! That's a "safe asset"? More like a "depreciating asset that pays no income."

I wonder: When we talk about markets, we assume investors are rational, and we believe in efficient market theory.

So, what is rational about buying gold?

William said...

Since it is vacation time, more ED Yardini on "Forward Earning" Prediction for S&P.

"....Yet again, I am impressed to see the forward earnings of the S&P 500, S&P 400, and S&P 600 rising to record highs last week. The S&P 500 forward earnings is at $119.29 per share and converging toward analysts’ consensus expectation for 2014, which has stabilized recently just under $123.

....The bottom line is that forward revenues, which has been more volatile than forward earnings, rose to a new record high (Fig. 7). I calculate that the forward profit margin rose to a new cyclical high of 10.3%, nearing the previous peak of 10.5% during the week of August 30, 2007.

Yesterday, I reviewed some of the latest economic indicators that might indicate where earnings might surprise to the upside and downside during the Q3 earnings season next month. Yesterday’s industrial production release for August suggests that positive surprises are likely from the following industries: auto products, appliances, furniture, carpeting, transit equipment, and industrial equipment.

Scott Grannis said...

Iluninati: Interest rates should continue to rise just about everywhere if economies continue to improve.

Illuninati said...

"Interest rates should continue to rise just about everywhere"

Thank-you. I was hoping to hide out in overseas bonds. Perhaps this ploy will not work. The remaining solution for bonds seems to be short term bonds which are less volatile.

The other question is where the currency is headed. The chronic US debt should push down the dollar but with a deficit which is dropping the dollar might not be too bad if the politicians do the right thing. What is your take?